Detailed Rationale

CRISIL Ratings continues its rating on the lower tier II bonds of North East Small Finance Bank Limited (NESFB) on ‘Rating Watch with Developing Implications’.

 

On October 4, 2023, the bank announced the receipt of a no objection certificate from the Reserve Bank of India (RBI) for its scheme of arrangement with the Slice group whereby the latter is to get amalgamated into NESFB. As part of this scheme, RGVN (North-East) Microfinance Ltd, which held 79.43% stake in NESFB as on June 30, 2023, and is classified as its promoter entity, will get reverse merged into the bank. The scheme is expected to come into effect in 2-4 quarters, subsequent to which only one entity, NESFB, shall exist. The proposed merger is subject to various regulatory approvals, and developments regarding this will remain key monitorable.

 

The rating continues to reflect the established market position of NESFB in Northeast India, supported by the experience of its management; and the bank’s moderate deposit profile. These strengths are partially offset by prolonged weakness in asset quality due to challenges in core operating territories, leading to modest earnings profile; weak capitalisation; and heightened susceptibility to local socio-political issues.

 

Asset quality remained weak due to the impact of the pandemic and floods in Assam (84% of the gross portfolio as on June 30, 2023) and the adjacent north-eastern region. As a result, gross non-performing assets (NPAs) surged to 18.2% as on March 31, 2023, and further to 24.9% on June 30, 2023, from 10.9% on March 31, 2022. Subsequently, in line with its initial plan, the bank sold its entire stressed loan portfolio of Rs 535.23 crore (excluding technical write-offs) to Edelweiss ARC (asset reconstruction company) with a cut-off date of September 30, 2023. The sale was executed on November 23, 2023. Following this, GNPA and net non-performing assets were reported to be nil. The bank received Rs 149.9 crore towards sales consideration of this portfolio, and subscribed to investment in security receipts of Rs 127.4 crore.

 

Standalone capitalisation remained weak, as reflected in a lower than regulatory minimum overall capital adequacy ratio (CAR) of 6.5% as on June 30, 2023. As per the bank’s earlier plan of raising capital of Rs 150-200 crore before the scheme of arrangement comes into effect, it raised Rs 50 crore in October 2023 from the Slice group and is likely to raise another Rs 50 crore in January 2024. After including the effect of capital raised in October 2023 and sale of stressed pool to ARC, CAR and Tier-I ratio were estimated to be 6% and 3.7%, respectively, as on November 30, 2023. CRISIL Ratings understands that further capital will be raised to meet the minimum regulatory requirement. The bank’s ability to expedite the restoration in capitalisation metrics remains a key rating sensitivity factor. CRISIL Ratings also understands that the overall CAR of the merged entity, on a pro-forma basis, was close to 30% as on March 31, 2023.

 

Profitability remains constrained by compressed margins due to portfolio degrowth and elevated credit costs. For fiscal 2023, the bank reported loss of Rs 213 crore vis-à-vis loss of Rs 123 crore for fiscal 2022. For the first-half of fiscal 2024, the loss was Rs 43 crore against Rs 32 crore for the corresponding period previous fiscal.

 

In terms of liability franchise, NESFB had a deposit base of Rs 1,585 crore as on September 30, 2023, with retail deposits forming 66% and CASA (current account and savings account) forming ~29% of the total deposits. Ability to maintain the CASA and deposit ratios post-merger will remain a key monitorable.

Analytical Approach

CRISIL Ratings has assessed the standalone business and financial risk profile of NESFB.

Key Rating Drivers & Detailed Description

Strengths:

• Established position in the north-eastern region supported by the extensive experience of the management: NESFB has a strong track record in Northeast India. Before starting operations as a bank in October 2017, it operated as a non-banking financial company-microfinance institution (NBFC-MFI), RGVN (North East) Microfinance Ltd, since 2008. As on June 30, 2023, the bank is spread across 62 districts in nine states, with a network of 226 branches. It had gross advances of Rs 1,633 crore as on September 30, 2023, against Rs 1,908 crore as on March 31, 2023. Deposit base stood at Rs 1,585 crore on September 30, 2023, against Rs 2,040 crore on March 31, 2023. While the business has been scaling down owing to capital constraints and pandemic-related asset quality issues, the bank’s position in Northeast India remains strong, which has the potential to support future growth prospects.

 

The bank also benefits from the presence of an experienced board and senior management comprising renowned professionals from the financial services sector. In light of the proposed merger, the bank will further benefit from the Slice group’s technical expertise, which will allow it to expand digitally. CRISIL Ratings also notes the appointment of Mr Satish Kumar Kalra as interim MD and CEO of NESFB.

 

• Moderate deposit profile: Over five fiscals of its operational history as a bank, NESFB has built a stable deposit profile. Deposit base of Rs 1,585 crore as on September 30, 2023,  constituted 85.0% of total borrowings,  against 68.6% as on March 31, 2021, and 20% as on March 31, 2019. Moreover, deposit mix has been evolving, with focus on retail deposits. The share of CASA deposits in total deposits was stable at 35.9% as on June 30, 2023, compared with 35.6% as on March 31, 2022. Aggregate share of retail deposits (savings and retail term deposits below Rs 2 crore) in the total deposit base grew to 58.8% as on June 30, 2023, from 38% as on March 31, 2022. On September 30, 2023, the bank had an estimated CASA ratio of ~29%.

 

In terms of tenure-wise break-up as of June 2023, 55.6% of term deposits are stable with a tenure of over a year. The bank has bulk deposits from government-linked institutions  in Northeast India, with which it has strong relationships. With growth in deposit base, cost of funds has improved over time, thereby aiding profitability. For the first half of fiscal 2024, cost of funds was 6.5% (annualised) against 7.9% for fiscal 2021 and 9.1% for fiscal 2020. Over the medium to long term, the bank’s ability to maintain a stable and granular deposit mix and sustain cost of funds post-merger will be a key monitorable.

 

Weaknesses:

• Prolonged weakness in asset quality and earnings profile: Asset quality started deteriorating due to political uncertainty in Assam during the pandemic outbreak, as borrowers faced liquidity challenges. To add to it, political parties announced loan waivers as part of election campaigns. Consequently, GNPAs, which were below 2% as of March 2020, rose to 24.9% as on June 30, 2023, from 10.9% as on March 31, 2022.

 

In November 2023, the bank sold its entire stressed loan portfolio of Rs 535.23 crore (excluding technical write offs) to Edelweiss ARC with a cut-off date of September 30, 2023. It received Rs 149.86 crore towards sales consideration, and the bank has subscribed to investment in security receipts of Rs 127.38 crore. With effect October 1, 2023, this portfolio no longer exists with the bank.

 

These asset quality challenges resulted in elevated provisioning requirement, which impacted overall profitability. Return on assets (RoA) stood at -5.2% in fiscal 2022 and declined to -8.2% in fiscal 2023 as credit costs increased to 7.9% (Rs 277 crore) and 8.8% (Rs 227 crore) of total assets in the respective fiscals. However, the bank provided for majority of the stressed assets in fiscal 2023, resulting in an increased provisioning coverage of 92% and net NPA of 1.7% as on March 31, 2023. For the first half of 2024, the bank reported loss of Rs 43 crore on account of thin net interest margin and elevated provisioning requirements.

 

The bank has adopted a highly calibrated growth strategy for its loan book until the scheme of amalgamation comes into effect, and this is expected to impart some stability in asset quality in the near term. Consequently, credit costs are expected to start tapering down gradually, leading to normalisation in profitability in the normal course of business. Over the near term, the pace and magnitude of improvement in asset quality and its ability to accelerate revival in overall profitability and sustain it at optimal levels, remains critical and a key rating sensitivity factor.

 

• Weak capitalisation, implementation of capital infusion plan remains critical: NESFB was adequately capitalised until fiscal 2021. However, as credit losses surged in the aftermath of socio-political challenges in Assam, losses started to accumulate. This increase in stressed portfolio resulted in losses in fiscals 2022 and 2023 and eroded networth to Rs 106 crore in June 2023 from Rs 372 crore in March 2021. Correspondingly, the overall CAR declined to 6.5% as on June 30, 2023, thereby breaching the regulatory stipulation of 15%. The bank had reported an overall CAR of 11.3% as on June 31, 2022, after which it received capital infusion of Rs 43.9 crore that restored this metric to 16.34% on September 30, 2022. Subsequently, as the bank reported further losses for fiscal 2023, CAR declined to below regulatory stipulation in March 2023 and has remained so over the first half of fiscal 2024. Networth reduced to Rs 70.8 crore as on September 30, 2023.

 

In October 2023, the bank received Rs 50 crore from the Slice group, in addition to Rs 10 crore received in the first quarter of this fiscal and Rs 30 crore in fiscal 2023. After factoring in this recent capital infusion and the sale of stressed assets to ARC in November 2023, the capital adequacy ratio of the bank stood at 6% (Tier-I at 3.5%), which was still below the regulatory stipulation levels. The bank continues to explore various options for raising incremental capital. This infusion is expected to uplift CAR to above 15% by April 2024. The quantum and timing of this capital infusion, along with its ultimate impact on the capitalisation metrics, will be key monitorable.

 

• Regional concentration and exposure to socio-political risks inherent in the micro loan business: A significant portion (over 50% as on September 30, 2023) of the portfolio comprises micro loans to clients with below-average credit risk profiles and lack of access to formal credit. These customers belong to the semi-skilled, self-employed category and their incomes tend to fluctuate, depending on the local economy. Slowdown in economic activity put pressure on cash flow of such borrowers, thereby restricting their repayment capability. This segment of borrowers is subject to idiosyncratic risks on account of socio-political factors. Considering the sensitivity of this market segment to socio-political unrest, the ability of the bank to reinstate repayment discipline among customers to pre-Covid levels will remain a key monitorable. As far as the non-microfinance segment is concerned (47% of the loan book as on June 30, 2023), the bank has a limited track record with low vintage. Additionally, its portfolio remains concentrated (84% of the loan book as on June 30, 2023) in Assam. After amalgamation of NESFB with Slice group, the merged entity’s market position has the potential to benefit from the latter’s digital presence. However, ability to demonstrate improvement from this synergy is yet to be seen.

Liquidity: Adequate

Liquidity position remains comfortable as bank is maintaining large amount of surplus in view of the business environment. It had excess statutory liquidity ratio of Rs 59.3 crore and liquidity cover of 119.6% as of September 2023. The bank also has refinance lines available from National Bank for Agriculture and Rural Development (NABARD) and Small Industries Development Bank of India (SIDBI).

Rating Sensitivity factors

Upward factors

• Restoration of asset quality and profitability to pre-Covid levels or better, and sustenance thereof on steady state basis.
• CAR restoring to and remaining above 15% on a steady state basis, coupled with improvement in profitability.

 

Downward factors

• Inability to restore the capital adequacy ratio to above minimum requirement of 15% and maintain it at that level thereafter.
• Lack of improvement in asset quality resulting in GNPA remaining elevated and straining the profitability.

About the Company

NESFB started operating as a society, Rashtriya Gramin Vikas Nidhi, with an initial corpus contribution from Industrial Development Bank of India (IDBI) and Industrial Finance Corporation of India (IFCI) and later from NABARD and Dorabji Tata Trust, which forayed into microfinance activities with the help of SIDBI in 1995. In 2008, a new company, RGVN (North East) Microfinance Ltd, was incorporated. It obtained the NBFC licence in August 2010 and the NBFC-MFI certification from the RBI in 2014, and an in-principle approval from the RBI to set up a small finance bank in 2015.

 

In July 2016, NESFB was incorporated as a 100% subsidiary of RGVN (North East) Microfinance Ltd. Headquartered in Guwahati, it started operations in October 2017 and got fresh equity infusion from Dia Vikas Capital Pvt Ltd; NMI Fund III KS, Norway; OikoCredit Ecumenical Development Co-operative Society UA, the Netherlands; and through conversion of optionally convertible preference shares (OCPS) by SIDBI. In fiscal 2019, the RBI granted the scheduled commercial bank status to the bank. On October 03, 2023, the RBI gave its no objection certificate for merger of the Slice group with the bank.

 

As on June 30, 2023, NESFB is present in nine states, with 84% of the portfolio concentrated in Assam. It caters to over 7.4 lakh customers through 226 branches. The assets under management stood at Rs 1,633 crore as on September 30, 2023. The bank also had outstanding deposits aggregating Rs 1,585 crore.

Key Financial Indicators

Particulars for the period ended	Unit	Sep-23	Mar-23	Mar-22	Mar-21	Mar-20
Total assets	Rs crore	2,044	2,710	2,352	2,258	2,067
Total income	Rs crore	161	335	329	332	325
PAT	Rs crore	(43)	(213)	(123)	7	13
Gross NPA	%	Nil	18.2%	10.9%	11.1%	1.9%
Overall CAR	%	3.4%	5.5%	17.05%	21.22%	24.98%
RoA@	%	(3.6%)	(8.2%)	(5.3%)	0.3%	0.7%

@Annualised for H1FY24

Any other information: Not Applicable

Annexure - Details of Instrument(s)

ISIN	Name of instrument	Date of allotment	Coupon rate (%)	Maturity date	Issue size (Rs.Crore)	Complexity Level	Rating assigned with outlook
NA	Lower Tier-II Bonds (under Basel II)^	NA	NA	NA	50	Complex	CRISIL BB+/Watch Developing

^Of this, the bank has raised Rs.19 crore in fiscal 2023 via a Promissory Note - the remaining amount yet to be issued.